It’s been a tough year for oil and gas producers. On February 10th, West Texas Intermediate fell to a twelve-year low of $26.14 per barrel. Naturally, with such a prolonged decline in oil prices over the past year, came also the decline in the financial health for companies producing it.
Throughout Canada and the United States, there has been round after round of company layoffs, asset divestitures, and corporate restructurings for oil and gas producers. Just this week, Encana announced a forthcoming 20% decrease in their workforce to take place over the coming year. Amidst the turmoil, there was even a new term that sprang up describing certain oil companies: zombie oil companies. These are corporations only really able to allocate capital spending to pay interest on their debts and nothing more. The mere thought of a sizable capital budget to drill for more oil remained just that: a mere thought!
Generally speaking, the upstream side of the business, those companies dealing strictly with finding and bringing the oil up from the ground, have had it worse for wear. And as you can imagine, so have the investors that haven’t already sold their oil shares and taken a loss.
But of course, there are always two sides to a trade when buying and selling stocks. When someone buys the stock your selling, that person has for some reason, confidence that it will eventually go up. Otherwise, why buy? Just as the seller must think there is no longer any hope, the buyer sits in the opposite camp. The obvious question that remains is: who’s right? Who’s the smart money?
Your Uncle Alex, who thinks oil can only keep going down, screams as he tells his broker to sell any oil shares he may own. Having just retired after thirty years in the public school system teaching grade five gym class, Uncle Alex finds himself killing time by watching CNBC’s Jim Cramer try and pick stocks. He also just saw the Big Short in theatres and came away inspired. I’m an outsider too and I know something about oil, he thinks confidently. Despite his broker suggesting he hold on to his shares…no! He won’t have it! And with that, liquidates his energy position.
The buyer of those stocks on the other hand, happens to be a guy sitting in an oak paneled, Connecticut office, managing a billion-dollar hedge fund focusing solely on the oil and gas industry. After getting his Harvard MBA – proving his ‘best and brightest’ status, this guy has worked day and night, year after year, pouring over every piece of information and data point relevant to the oil industry. All this effort, just so he can get some sort of an idea, but not too good of an idea, where the price of oil may go!
So who’s right? Uncle Alex or Master of the Universe hedge fund manager?
With oil hitting a twelve-year low earlier this month, many in the mainstream media have reasoned the price of crude oil finally has hit its bottom. However, as you may recall, this same sentiment was shared by many last summer when oil was sitting at $60 per barrel.
“Looking at the S&P 500 (SPX) vs. S&P 500 Energy it is clear that energy stocks have performed poorer than the SPX and that a trough was reached in Jan 20 2016. It has picked up since then but in this volatile market nothing is certain” – Pavle Sabic
Prior to the crash, and despite story after story of increased North American shale oil production (the shale revolution) it seemed oil would remain at or around the $100 mark. Clearly something had to give. The global demand for oil, while steadily increasing, nonetheless was being outpaced by supply. Not surprisingly, soon the price of oil started to fall. But why did this come as such a surprise? And why, last summer, was there such conviction that oil couldn’t go any lower than $60 (after the price had already fallen so far?) As many thought at the time, there was no way it could keep going down. But of course, it did.
And so now, as industry pundits grow used to WTI hovering around the current $30 mark, it should come as no surprise when you hear in the press that oil can’t possibly go any lower.
Again, who’s to know? Obviously the answer is nobody! Nobody has a crystal ball that works. Although they may say they do, they don’t. If they did, they would likely be planning their next trip to a five star Maldivian resort (or planning to buy it in the hedge fund manager’s case), rather than losing sleep over where the price of oil will go tomorrow.
But if it’s any indication, lately, there has been a handful of sophisticated hedge funds betting on the energy industry improving.
The quarterly Hedge Fund Tracker from S&P Global Market Intelligence, tracks hedge fund 13F filings by pure play hedge funds. 13F filings are quarterly filings required by the United States’ SEC for institutional investment managers with over $100 million in qualifying assets. It provides investors with an inside look at the holdings of Wall Street’s largest investment managers.
In the S&P report, it was revealed that despite energy being the S&P 500’s worst performing sector of 2015, energy stocks were the most-bought sector by pure play hedge funds in the fourth quarter. The ten largest hedge funds bought $1.5 billion in energy sector stocks with Pioneer Natural Resources, a large upstream oil and gas company, and Williams Company, a midstream oil and gas company ranking as the most-bought single energy stocks.
Source: S&P Global Market Intelligence’s Hedge Fund Tracker
Which hedge funds are the buyers you may ask? “Lone Pine Capital, Icahn Capital, and Viking Global Investors were the biggest buyers,” says Pavle Sabic, head of market development at S&P Global Market Intelligence.
“Lone Pine went heavy into Williams, Cheniere Energy and Pioneer Natural Resources,” says Sabic. “As well, Icahn Capital increased their stake in Cheniere, and Viking [Global Investors] made four 13G filing’s (ownership of more than 5% of the company) in January Gulfport Energy, Range Resources, Southwestern Energy and Cabot Oil and Gas.”
For Viking, a fund managing more than $30 billion, “this is a significant move into the energy sector,” says Sabic.
But as for exactly why these hedge funds are so bullish on energy, one can only assume that they believe the worst has come to pass for oil and gas. Pavle Sabic however, isn’t jumping to any conclusions. “One cannot be certain, but the considerable discount that the energy stocks are trading at would make them appealing for the hedge funds.”
Some of Wall Street’s biggest players have started betting on American oil and gas stocks. Are these funds on the smart side of the trade? Of course, that remains to be seen. But despite your Uncle Alex’s vehement opposition to such thinking, still, it’s an encouraging sign.